Excessive Risk Taking Led to Nonprime Mortgage Boom

CAMBRIDGE, MA - The boom and then bust of nonprime mortgage lending in the United States caused enormous damage to individuals, communities, the national economy, and the global financial system.  In a report released today, researchers at the Joint Center for Housing Studies of Harvard University conclude that the origination of excess risk in the primary mortgage market was inextricably linked to demand on the secondary capital markets for mortgages with higher yields than prime mortgages, as well as the multiplication and magnification of this risk through actions taken in the capital markets. 

“The combination of a glut of global liquidity, low interest rates, high leverage, and regulatory laxity in the context of initially tight and then overvalued housing markets triggered staggering risk taking,” says Eric S. Belsky, managing director of the Joint Center and one of the study’s authors. “Capital markets supplied credit through Wall Street in large volumes for risky loans to risky borrowers and then multiplied these risks by issuing derivatives that exposed investors to risks in amounts much larger than the face amount of all the loans.”

Many other nations, the report points out, saw booms in home prices during the first half of the 2000s as mortgage interest rates globally fell sharply and stayed there for a time.  In deciding how much to bid for a home, homebuyers tend to focus on monthly payments, and lower mortgage rates allowed them to chase prices higher in the context of housing markets that were tight—at least at first. Once house price appreciation took off, the report suggests, backward looking price expectations led both homebuyers and mortgage investors to count on rapidly rising prices, which further fuelled a bubble. But the riskier nature of the loans tolerated in the US, the sheer volume of them, the share of them made to speculators,  and the way they were bundled into securities and written into credit default swaps caused much more damage to the US economy and global financial markets than did mortgage loans originated in these other nations.